The RiskSIGNAL Report: Is the Stock Market Running the Fed? - Issue #5

Opportunity always exists when the crowd thinks it knows an unknowable future - Michael A. Gayed

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The Ivory Hill RiskSIGNAL is firmly red, and we are still sitting around 60% cash levels.

The markets have gotten so bad that it might actually be a positive in the short term. Confidence has dropped to the lowest levels that I have seen in my career.

The NASDAQ is down -31.61% YTD and the S&P 500 is down -22.12% YTD.

The latest leg lower in stocks has seen the S&P 500 quickly approach the downside target of the bearish head-and-shoulders pattern that developed over the last few quarters. The S&P 500 has fallen 10% in just the last five sessions, which suggests the market is approaching oversold levels. However, there have been no signs of capitulation just yet and momentum is still decidedly bearish.

I want to be crystal clear, our downside target is based on fundamentals. During periods of high volatility fundamentals get tossed out the window.

The 10s-2s yield curve spread took a dive again after Goldman Sachs and JP Morgan changed their forecasts to reflect a 75 basis point hike, which is in line with market expectations. If the yield curve inverts for a second time, this will spark more selling.

The markets have been taken back by Treasury Secretary, Janet Yellen's, admission.

“I think I was wrong then about the path that inflation would take,”

"As I mentioned, there have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that at the time I didn’t fully understand”.

I appreciate her candor, but anyone with a basic knowledge of monetary policy could see that inflation was going to be an issue going back to 2020. The market doesn't believe Yellen's latest statement that the US will likely avoid a recession. In other words, the market is skeptical of the narratives coming from the Federal Reserve and the US Treasury.

The Reuters/University of Michigan Consumer Sentiment Index dropped 8.2 points in the preliminary June survey to 50.2, a record low, and far below the consensus of 59.0. It was the fifth decline in the past six months, as the sticker shock of higher gasoline and food prices continues to weigh on consumers. The assessment of current conditions dropped to its lowest level since May 1975, while consumer expectations were the worst since May 1980.

Target Corporation's recent profit and inventory warning, the second downgrade in the past several weeks, is likely not a one-off issue. We’ve been hearing about weakness from both the consumer and retail sectors, and this might be the best evidence yet that a major downturn is inevitable. The essence of the announcement is that Target is going to start offering deep discounts to clear out excess inventories to make room for things, like groceries and back to school supplies. Here is the real interpretation. Retail consumers are spending less as their COVID savings dry up and high food and energy prices are eating into their discretionary budgets.

Target overestimated consumer demand, possibly by a lot, and is now in the position to fix the problem. We’ve been hearing for a while that recession risk isn’t actually that high because unemployment is still low and the consumer is still strong. Target's announcement may just be the tip of the iceberg in destroying that argument.

It's difficult to believe that this problem isn't affecting consumers everywhere right now. Retail earnings were already poor last quarter, and now one of the biggest retailers has lowered its projections even further. It won't be long until we hear a similar narrative from Walmart, Costco, or other retailers in need of price cuts to move inventory that has been lying on the shelf for too long.

This isn't likely to be limited to the retail sector. What happens to the labor market when a company's operating margin expectations are sliced in half, forcing it to cancel orders and drop prices in order to clear inventory? It begins by cutting expenditures elsewhere, with employee compensation being one of the most significant. Don't be surprised if you start hearing about layoffs as the downturn intensifies. The Fed will switch to a more dovish stance in an effort to avoid a recession if the labor market cools and consumer spending slows, but by that time it will probably be too late.

One of the worst parts about a recession is...

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Best regards,

-Kurt

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Kurt S. Altrichter, CRPS®

Fiduciary Advisor | President

Direct: 952.828.5336

Email: kurt@ivoryhill.com | ivoryhill.com

8400 Normandale Lake Blvd, Suite 920, Bloomington, MN 55437

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